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Is socially-responsible investing right for you?

Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

Posted: May 19, 2016
Personal finance

min read

Among the wide variety of investment strategies available to you, there are some approaches that are not geared primarily toward following a given theory of investing or capturing a specific market sector, but instead are concerned with putting religious or moral principles to work in an investment portfolio. If you believe your investments should reflect your principles, you will want to learn more about socially-responsible investing.

Examples of social directives for investing

Broadly speaking, there are two types of socially-responsible portfolio directives: positive ones that direct money to be invested in certain types of companies, and negative ones that ban specific companies or industries from the portfolio.

Here are six common examples of social portfolio directives:

1. Human rights

Typically, this would be a negative directive, banning investments in companies that do business in countries with poor human rights records, or those that don't treat their employees fairly.

2. Anti-violence

This typically would be expressed as a ban on gun manufacturers and military contractors.

3. Green businesses

This might be a positive directive to invest in renewable energy companies, or a negative one to ban stocks of heavy polluters.

4. Pro-life

Pro-life views can be expressed as a ban investments on pharmaceutical companies that produce abortion-related products, on hospital groups that perform abortion procedures or even on medical insurance companies that cover such procedures.

5. No "sin" stocks

Alcohol, tobacco and pornography are favorite targets of portfolio bans by investors who believe their use to be sinful.

6. Religious affiliation

Some investment groups offer products geared specifically to the beliefs of a given religious affiliation, such as Catholic investment products that are pro-life and anti-violence, or Muslim products that invest according to sharia law.

Socially-responsible investing and restrictions

Because social investing either directs or restricts specific investments, it is very likely to result in different performance than market indexes and investment styles that are free to invest in anything. Some investment managers specializing in socially-responsible products try to sugar-coat this reality, but the simple fact is that limiting the field of investment opportunities may affect performance.

Whether or not that impact will be positive or negative is a fair question. There is an argument to be made that companies conducting their business responsibly or shying from harmful products will perform better financially in the long run. However, this greatly depends on the types of policies involved. In the short-term, socially-responsible investing may cause you to trail market indexes or other investors.

How to measure performance of socially-responsible investments

To the extent possible then, performance measurement should be handled by comparing to customized indexes, which also exclude or include investments according to your social investing guidelines. Also, when it comes to socially-responsible investing, rate of return is not the only measure. The extent to which the investment manager is rigorous in researching and implementing the desired socially-responsible policies should also be an important component of how that manager is evaluated.

Ways to implement a social investing policy

If you wish to pursue socially-responsible investing, there are a few ways to do it.

Mutual funds based on principles

There are some mutual funds that are constructed around certain religious or social principles, and this can be an efficient way to implement a socially-responsible approach as long as you are comfortable that your principles line up well with the policies being followed by the particular fund you choose.

Separately-managed portfolio with investment guidelines

When you have a separately-managed portfolio, you can customize your portfolio to your specific principles and priorities. If you do this, be sure to put your guidelines in writing, and be as specific as possible. Vague language about "good" or "bad" practices may result in your portfolio missing the mark because such generalizations are widely open to interpretation. Your investment guidelines should also describe performance measurement standards that reflect the policy you are pursuing.

Importance of updating investment guidelines regularly

If you establish socially-responsible investment guidelines, be sure to review and update those guidelines regularly because the issues involved are subject to change over time.

For example, one of the most prominent social investing movements was divestiture from companies doing business in South Africa during that country's apartheid years. Unfortunately, because they were slow to update their policies, some religious and academic groups kept those policies in place long after that country abolished apartheid - at a time when the new government of Nelson Mandela was starved for international investments.

Remember, if the purpose of your policy is to influence change, then don't neglect to adapt your policy when that change occurs.

Socially-responsible investing is a matter of personal choice. There may be some cost involved in restrictive investment policies, but to people who believe in such policies, the real reward is investing in a manner consistent with their values.

Comment: Do you participate in socially-responsible investing? Which causes or beliefs do you support when you're investing?

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